This document provides an overview of budgetary planning and control systems. It discusses the objectives of such systems which include ensuring communication, coordination, control and motivating employees. Various budgeting techniques are described such as top-down vs bottom-up budgeting, incremental budgeting, fixed vs flexible budgets, zero-based budgeting and activity-based budgeting. Feedback and feedforward control are also explained.

1. BUDGETARY & CONTROL
Prepared by Jessy Chong
URL: chongsk818.blogspot.com

2. OBJECTIVES
 A budgetary planning and control system is a system
to ensuring communication, coordination and
control within an organization.
 Ensure the achievement of the organisation’s objectives
 Compel planning
 Communicate ideas and plans
 Coordinate activities
 Provide a framework for responsibility accounting
 Establish a system of control
 Motivate employees to improve their performance

3. THE PLANNING AND CONTROL CYCLE
 Step 1: Identify objectives
 Step 2: Identify potential strategies
 Step 3: Evaluate strategies
 Step 4: Choose alternative course of action
 Step 5: Implement the long-term plan
 Step 6: Measure actual results and compare with
the plan
 Step 7: Respond to divergences from the plan

4. PLANNING & CONTROL IN THE PERFORMANCE
HIERARCHY
1) Corporate plans / Strategic plans
o Prepared at a strategic level by senior management
o Focus on overall corporate performance
o Environmental influence
o Set overall plans & targets for units and
departments
o Some times qualitative planning

5. TACTICAL PLANS (CONT’D)
2) Tactical plans
o Prepared at lower management level within guidelines set by
senior management
o Time horizon typically 12 months
o Plans for individual departments or activities, some budgets
may be prepared in non-financial terms, but all budgets are
converted into money values.
o The overall budget is expressed in financial terms, with a
budgeted financial statement.
o Provides a link between strategic plans at senior level and
operational planning.
o Budget targets should be consistent with strategic objectives
o Approved by senior management (Board of directors)

6. OPERATIONAL PLANS (CONT’D)
3) Operational plans
o Prepared by managers at a fairly junior level, at a
practical operational level.
o Based on objectives about ‘what’ to achieve in
operational terms
o Operational targets likely to be quantitative
o Detailed specifications of targets and standards
o Based on ‘how’ something is achieved
o Short time horizons

7. CONTROL
 Control involves two main processes.
i. Measure actual results against the plan.
ii. Take action to adjust actual performance to achieve
the plan or to change the plan altogether.

8. FEEDBACK CONTROL
 Feedback occurs when the results (outputs) of a system are
used to control it, by adjusting the input or behavior of the
system. Feedback is information produced as output from
operations; it is used to compare actual results with planned
results for control purposes.
 Feedback can be 2 signals:
o Negative feedback indicates that results or activities must be
brought back on course, as they are deviating from the plan.
o Positive feedback results in control action continuing the current
course. You would normally assume that positive feedback means
that results are going according to plan and that no corrective action
is necessary: but it is best to be sure that the control system itself is
not picking up the wrong information.

9. TYPES OF FEEDBACK
 Single loop feedback is control, like a thermostat,
which regulates the output of a system. For
example, if sales targets are not reached soon. The
plan or target itself is not changed, even though the
resources needed to achieve it might have to be
reviewed.
 Double loop feedback s of a different order. It is
information used to change the plan itself. For
example, if sales targets are not reached, the
company may need to change the plan.

10. FEEDFORWARD CONTROL
 This is a control based on forecast results: in
other words if the forecast is bad, control action
is taken well in advance of actual results.

11. TOP-DOWN BUDGETING
 Top-down budgeting, budget targets are set at senior
management level for the organization as a whole and for
each major department or activity within the organization.
 The departmental budget targets are then given to the
departmental managers, who are required to prepare a
budget that conforms to the targets that have been
imposed on them from above.
 The targets are then given to managers lower down the
organization hierarchy and they are required to prepare
budgets that meet the targets for their area of operations.

12. BOTTOM-UP BUDGETING
 Bottom-up budgeting, the budgeting process starts at a relatively low level of
management (operations).
 Draft budgets are submitted to their superior, who combines the lower-level
budgets into a combined budget for the department as a whole.
 Departmental budgets are then submitted to senior management, where they
are combined into a co-ordinate budget for the organization as a whole.
 Two potential advantages:
i. It reflects the views and expectations of mangers who are closer to operations
and so who may have a better understanding of what and what is not
achievable.
ii. Bottom-up budgeting is a form of participative budgeting process, which can
have behavioural and motivational advantages.

13. FACTORS TO CONSIDER
i. The attitudes of junior managers to their work.
ii. The skills of junior managers relating to
budgeting.
iii. The amount of interdependence between
departments.
iv. The amount of ‘local’ knowledge of senior
managers.
v. Culture of the organisation

14. INCREMENTAL BUDGETING
 Incremental budgeting is a method of budgeting
in which next year’s budget is prepared by using
the current’s year’s actual results as a starting
point, and making adjustments for expected
inflation, sales growth or decline and other
known changes.

15. USEFUL OF INCREMENTAL BUDGETING
 The budget is stable, and change is gradual.
 Managers can operate their departments on a
consistent basis.
 The system is relatively simple to operate and easy
to understand.
 Conflicts should be avoided if departments can be
seen to be treated similarly.
 Coordination between budgets is easier to achieve.
 The effect of change can be seen quickly.

16. PROBLEMS WITH INCREMENTAL BUDGETING
 Assumes activities and methods of working will continue in the same
way.
 No incentive for developing new ideas.
 No incentives to reduce costs.
 Encourages “spend it or lose” mentally so that the budget is maintained
next year.
 The budget may become out of date and no longer relate to the level of
activity or type of work being carried out.
 The priority for resources may have changed since the budgets were set
originally. Managers may have overestimated their requirements in the
past to obtain a budget which is easier to work to, and which will allow
them to achieve favourable results.
 There may be budgetary “slack” built into the budget, which is never
reviewed.

17. FIXED BUDGET
 The master budget, which is prepared and approved before the beginning of
the budget period, is normally a fixed budget. The term ‘fixed’ means the
following.
 The budget is prepared on the basis of an estimated volume of production
and an estimated volume of sales, but no plans are made for the event that
actual volume of production and sales may differ from budgeted volumes.
 When actual volumes of production and sales during a control period (month
or four weeks or quarter) are achieved, the budget is not adjusted or revised
(in retrospect) to the new levels of activity.
 The major purpose of a fixed budget is for planning. It is prepared at the
planning stage, when it is used to define the objectives and targets of the
organization for the budget period (financial year).

18. FLEXIBLE BUDGET
 A flexible budget is a budget which, by
recognizing different cost behavior patterns, is
changed as the volume of output and sales
changes. It recognizes cost behavior patterns,
such as changes in sales revenue and variable
costs as sales volumes change, and step changes
in fixed costs as activity levels rise or fall by more
than a certain amount.

19. ZERO BASED BUDGETING (ZBB)
 Zero based budgeting or also called as priority based budgeting,
involves preparing a budget for each cost centre from a zero base.
 Every item of expenditure has then to be justified in its entirety in order
to be included in the next year’s budget. It is a method of budgeting
which requires each cost element to be specifically justified, as though
the activities to which the budget relates were being undertaken for the
first time. Without approval, the budget allowance is zero.
 ZBB is the opposite of incremental budgeting. Instead of creating the
budget based on last year, in ZBB they create a budget as if that is the
first year every time. (ie. There is never a last year to be referred to!)

20. IMPLEMENTING ZERO BASED BUDGETING
 There are several formal stages involved in implementing a ZBB system but of greater
importance is the development of an appropriate questioning attitude by all concerned.
There must be a ‘value for money’ approach which challenges existing practices and
expenditures and searching questions must be asked at each stage; typical of which are
the following:
a) Does the activity need to be carried out at all? What would be the effects, if any, if it
ceased?
b) How does the activity - existing or proposed - contribute to the organisation's
objectives?
c) What is the correct level of provision? Has too much or (too little been provided in
the past?
d) What is the best way to provide the function? Have all alternative possibilities been
considered?
e) How much should the activity cost? Is this expenditure worth the benefits achieved?
f) Is the activity essential or one of the frills? Etc.

21. BASIC APPROACH OF ZBB
Step 1: Define Decision Packages
o Decision packages are activities or items in the
budget about which a decision should be made.
Should this activity be included in the budget or
not? Decision packages are used to rank
activities in order of priority or preference. This
ranking can be used to allocate scarce resources
in the budget. Decision packages must be
thoroughly documented.

22. TWO TYPES OF DECISION PACKAGES
a) Mutually Exclusive Packages
 These are alternative forms of activity, tasks and expenditure to carry
out the same job. The best option among the mutually exclusive
packages is selected by comparing costs and benefits, and the other
packages are then discarded. If there are two mutually exclusive
decision packages, the preferred package is selected and the other
rejected for budgeting purposes.
 Naturally, mutually-exclusive packages would only be prepared when
there are quite clearly different approaches for dealing with the same
function. Example, an organisation with a distribution problem might
consider two alternative decision packages: Package 1 might be an in-
house fleet of lorries, whereas Package 2 could involve contracts with
independent haulers.

23. CONT’D
b) Incremental Packages
 These packages reflect different levels of effort in dealing with
a particular activity. There will be what is known as the base
package, which represents the minimum feasible level of
activity, and other packages which describe higher activity
levels at given costs and resulting benefits.
 Example, a base package for Personal Department might
provide for staff engagement and termination procedures and
payroll administration. Incremental packages might include;
education and training, welfare and social activities, pension
administration, trade union liaison and negotiations etc. Each
package would have its costs benefits clearly tabulated.

24. STEP 2: EVALUATE AND RANK EACH DECISION
PACKAGE
 When the decision packages have been prepared; management will then rank
all the packages on the basis of their benefits to the organisation. This is a
process of allocating scarce resources between different activities, some of
which already exist and other that are new.
 Minimum requirements which are essential to get the job done and activities
necessary to meet legal or safety obligations will naturally receive high priority.
It’s been found that the ranking process focuses management's attention on
discretionary or optional activities.
 Because of the large number of packages prepared throughout the
organisation, the ranking process can become onerous and time consuming for
senior management. One way of reducing this problem is for lower level
managers to level up the hierarchy. Alternatively, there could be cut-off limit
for expenditure so that packages for a lower amount, say less than $2,000,
could be ranked within the department and need not be referred higher.

25. STEP 3: ALLOCATE RESOURCES
 When the overall budgeted expenditure level is
decided upon the packages would be accepted in
the ranked priority sequence up to the agreed
expenditure level. When the ranking of lower cost
packages has been delegated to departments the
proportion of the expenditure budget remaining
after the more expensive packages have been
ranked would be allocated to individual
departments. The departments would then rank
their own small packages up to their allocated
expenditure level.

26. ADVANTAGES OF ZBB
a) Properly carried out, it should result in a more efficient allocation of
resources to activities and departments and provides a framework to
ensure the optimum utilisation of resources by establishing priorities
in relation to operational activity.
b) ZBB focuses attention on value for money and makes explicit the
relationship between the input of resources and the output of
benefits.
c) It develops a questioning attitude and makes it easier to identify
inefficient, obsolete or less cost-effective operations and it
concentrates the attention of management on the future rather than
on the past
d) The ZBB process leads to greater staff and management knowledge of
the operations and activities of the organisations and increase
motivation.

27. ADVANTAGES OF ZBB (CONT’D)
e) It is a systematic way of challenging the status quo and
obliges the organisation to examine alternative activities and
existing cost behaviour patterns and expenditure levels and
can assist motivation of management at all levels
f) It helps to create an organisational environment where
change is accepted;
g) It helps management to focus on company objectives and
goals;
h) It provides a plan to follow when more financial resources
become available;
i) It establishes minimum requirements from departments;
j) It can be done piecemeal.

28. DISADVANTAGES OF ZBB
a) It is a time consuming process which can generate volumes of paper
work especially for the decision packages.
b) There is considerable management skill required in both drawing up
decision packages and for the ranking process. These skills may not
exist in the organisation.
c) It may encourage the wrong impression that all decisions have to be
made in the budget. Circumstances change and new opportunities
and threats can arise at any time and organisations must be flexible
enough to deal rapidly with these circumstances when they occur.
d) ZBB is not always acceptable to staff or management or trade unions
who may prefer the cosy status quo and who see the detailed
examination of alternatives, cost and benefits as a threat not a
challenge.

29. DISADVANTAGES OF ZBB (CONT’D)
e) There are considerable problems in ranking packages and
there are inevitably many subjective judgements.
Political pressures within organisations also contribute to
the problem of ranking different types of activity,
especially where there are qualitative rather than
quantitative benefits.
f) It may emphasise short term benefits to the detriment of
longer term ones which in the end may be more
important.
g) It takes time to show the real benefits of implementing
such a system.

30. ACTIVITY BASED BUDGETING
 Activity based budgeting (ABB) follows principles of activity based costing
(ABC) “in reverse”. Having decided how many units to produce and sell, then
organization then needs to define the cost of the activities required to produce
them. These depend on the drivers identified for each activity.
 A typical ABB exercise may follow these steps:
1) Estimate the expected output (units) for each product.
2) Identify the number of units of each activity which will be required to produce
the output. This is based on knowledge of the relationships between the output
and the activities required to be performed to produce the output.
3) Determine the resources needed to perform the activities required. This is based
on knowledge of the drivers – the factors which influence the price of the
activities.
4) If the current commitment of resources is such that too many or too few
resources exist to perform the activities required in Step 3, and then adjust
accordingly.

31. ADVANTAGES OF ABB
a) Management attention is focused on the
activities of the organization. These are
something which management can control
more easily than focusing on total costs.
b) Better understanding of what causes costs to be
incurred may provide opportunities for cost
reductions.
c) May identify non-value added activities which
can be estimated.

32. DISADVANTAGES OF ABB
a) Complicated and expensive to implement. More
suited to large organizations with multiple
products and many drivers.
b) Many fixed costs do not vary with changes in
the volume of drivers in the short run – so ABB
may provide misleading information.

33. ROLLING BUDGETS
 Rolling budgets (also called continuous budgets) are
budgets which are continuously updates by adding a
further accounting period (a month or quarter) to the end
of the budget when the corresponding period in the
current budget has ended.
 This approach to budgeting helps to eliminate the adverse
impact of environmental uncertainties on setting goals by
updating the budget in quick succession.
 This budget encourages a forward-looking attitude.

34. ADVANTAGES OF ROLLING BUDGETS
a) They reduce the element of uncertainty in budgeting because they
concentrate detailed planning and control on the near-term future,
where the degree of uncertainty is much smaller.
b) They force managers to reassess the budget regularly, and to produce
budgets which are up to date in the light of current events and
expectations.
c) Planning and control will be based on a recent plan which is likely to
be far more realistic than a fixed annual budget made many months
ago.
d) Realistic budgets are likely to have a better motivational influence on
managers.
e) There is always a budget which extends for several months ahead.
For example, if rolling budgets are prepared quarterly there will
always be a budget extending for the next 9 to 12 months. This is not
the case when fixed annuals budgets are used.

35. DISADVANTAGES OF ROLLING BUDGETS
a) They involve more time, effort and money in budget
preparation.
b) Frequent budgeting might have an off-putting effect on
managers who doubt the value of preparing one budget after
another at regular intervals.
c) Revisions to the budget might involve revisions to standard
costs too, which in turn would involve revisions to stock
valuations. This could replace a large administrative effort
from the accounts department every time a rolling budget is
prepared.
d) The benefits of rolling budgets are limited, and so not worth
the extra cost, when the rate of charge in the business
environment is not rapid and continual.

36. MASTER BUDGETS
 Master budget is a consolidation of the various
operational and financial budgets. It is a
projected financial plan. Budgeted financial
statements are prepared on the basis of the
master budget.

37. ADVANTAGES OF MASTER BUDGETS
a) It helps to co-ordinate all the other budgets and to devise the
short-term objectives of an organization. Any conflict
between departments is resolved by the master budget as it
is a consolidation of all the functional budgets.
b) It is a good medium of communication between the various
departments as it consolidates the functional budgets.
c) It enables an overall plan for achieving the budget targets to
be prepared. Budget income statements, budgeted cash flow
statements and forecasted balance sheets are prepared using
the master budget.
d) The master budget incorporates the targets of every
department and therefore acts as a measure of performance
evaluation.

38. DISADVANTAGES OF MASTER BUDGETS
a) Budgets are based on forecasting. This means
they are vulnerable to uncertainty in the
environment.
b) Master budget is based on certain assumptions
that may not prove correct over the period.

39. FUNCTIONAL BUDGET
 Functional budgets are prepared for an
individual function. For each operation in the
organization a budget is prepared.
 Sales budget, Purchase budget, Production
budget, Cash budget etc. are examples of a
functional budget. These budgets are
consolidated to arrive at a master budget.

40. ADVANTAGES OF FUNCTIONAL BUDGET
a) A functional budget gives targets to the
individual functional manager.
b) Those who actually implement the budget
prepare the functional budget. They are familiar
with the problems at the grass-root level.
Therefore the budgets are more realistic and
motivating.

41. DISADVANTAGES OF FUNCTIONAL BUDGET
a) As the functional managers prepare the functional budgets,
the targets may not be in line with the strategic objectives or
may conflict either with the organizational objectives or inter-
departmental objectives. This problem can be avoided by
encouraging co-ordination between the functional managers.
b) Functional budgets are based on forecasts. There are many
external as well as internal environmental factors (such as
change in demand for a product, non-availability of a
particular raw material, high attrition causing shortage of
skilled labourers, etc) that affect the functional budgets. If
these factors behave differently than predicted, this may
render the budgetary system ineffective.

42. INFORMATION USED IN BUDGET SYSTEMS
 Sales Budget Information
 Before the sales budget can be prepared a sales forecast has to
be made. Sales forecasting is complex and difficult and involves
the use of information from a variety of sources.
 Past sales patterns New legislation
 The economic environment Distribution
 Results of market research Pricing policies and discounts
offered
 Anticipated advertising Legislation
 Competition Environmental factors
 Changing consumer taste

43. PRODUCTION BUDGET INFORMATION
 Sources of information for the production budget
will include:
a) Labour costs including idle time, overtime and
standard output rates per hour.
b) Raw material costs including allowances for losses
during production.
c) Machine hours including expected idle time and
expected output rates per machine hour.

44. CHANGING BUDGETARY SYSTEMS
 An organization wishing to change its budgetary practices will face a number of
difficulties.
a) Resistance by employees. Employees will be familiar with the current system and
may have built in slack so will not easily accept new targets. New control systems that
threaten to alter existing power relationships may be thwarted by those affected.
b) Loss of control. Senior management may take time to adapt to the new system and
understand the implications of results.
c) Costs of implementation. Any new system or process requires careful implementation
which will have cost implications. For example, the procedures for preparing budgets
will have to be re-written in a new budget manual. Establishing a system of zero
based budgeting, for example, will require the design and documentation of a large
number of decision packages.
d) Training. In order to prepare and implement budgets under the new system,
managers will need to be fully trained. This is time-consuming and expensive.
e) Lack of accounting information. The organization may not have the systems in place
to obtain and anaylse the necessary information for preparing the new style budget.
For example, an organization needs a system of activity-based costing if it is to
implement ABB.

45. BUDGET SYSTEMS AND UNCERTAINTY
 Uncertainty can be allowed for in budgeting by means of flexible budgeting,
rolling budgets, probabilistic budgeting and sensitivity analysis.
 Causes of uncertainty in the budgeting process include:
a) Customers. They may decide to buy less than forecast, or they may buy
more.
b) Products/services. In the modern business environment, organizations need
to respond to customers’ rapidly changing requirements.
c) Inflation and movements in interest and exchange rates.
d) Volatility in the cost of materials.
e) Competitors. They may steal some of an organization’s expected customers,
or some competitors’ customers may change their buying allegiance.
f) Employees. They may not work as hard as was hoped, or they may work
harder.
g) Machines. They may break down unexpectedly.

46. h) There may be political unrest (terrorist activity), social unrest
(public transport strikes) or minor or major natural disasters
(storms, floods).
 Rolling budgets are a way of trying to reduce the element of
uncertainty in the plan. There are other planning methods
which try to analyse the uncertainty such as probabilistic
budgeting (where probabilities are assigned to different
conditions) and sensitivity analysis. These methods are
suitable when the degree of uncertainty is quantifiable from
the start of the budget period and actual results are not
expected to go outside the range of these expectations.